Volatility As An Asset: Hedging Against Market Downturns With VXX ETN

The Case for Volatility Products

Traditional investments can suffer during market swings, as uncertain and downward-trending markets can erode portfolio value. Volatility products can serve as a strategic addition, offering a potential hedge and potentially offsetting losses due to their decently negative correlation with the markets.

Volume and volatility are likely to increase under the following circumstances:

What are Futures?

In futures trading, the parties agree to carry out the transaction later at a predetermined price. The instrument helps primarily in handling risk. Consider a Farmer and a Baker entering a six-month futures contract where the price and quantity of the milk to be provided/received is predetermined. The dairy farmer is assured he will get an acceptable price for his milk in six months, even if the spot price of milk drops in the meantime. The baker knows he can secure the milk he needs to make his products at an acceptable price in six months, even if the spot (actual) price of milk rises. Instead of doing it physically, futures contracts are standardised by quantity, quality, and asset delivery, making trading them on futures exchanges possible.

Now that we have understood what these instruments are, here are a few differences which can help you choose the instrument best suited to you:

Trading Structure/Medium of Exchange

CFDs - CFDs are predominantly traded over the counter (OTC) between you and your broker or trading provider over the counter, or OTC. Over the counter (OTC) deals are often more flexible. This implies you can draft unique agreements for you and your trading approach.

Futures - Futures are traded on exchanges. Here, you can buy or sell the future contract of the underlying financial instrument for the said expiration date. For instance, if you have a view of the underlying asset, say a stock XYZ going up, you can buy its futures at the standard expiry dates. If the spot price moves upward, so will the futures.

Asset Classes

CFDs - With CFDs, you can trade various asset classes, including futures, stocks, indices, commodities, currencies, cryptocurrencies, options and bonds.

Futures - Futures also cover a range of Assets. However, since they are mainly used as hedging instruments, commodities are the most well-known futures market. Still, if you’re looking for volume and liquidity, you might want to consider stock indices and currencies –these are the most highly traded futures markets.

Ownership of Assets

CFDs - In CFDs, since you do not own the underlying asset, you would permanently settle the position in cash. You do not become the owner of the underlying asset.

Futures - When you enter a futures contract at the expiry date, you have two options to settle your contract:

Contract Sizes

CFDs - Standardized lots replicate the underlying asset for CFD trading. Contracts may be traded in increments, however.

Futures contracts are standardised in quantity and quality and traded on major exchanges.

Expiry Date

CFDs - CFDs do not have an expiration date. You enter the contract to capitalise on the price difference between the contract's entry and exit.

Futures - Futures contracts specify the dates by which the relevant asset must be traded. Over the year, futures are broken down into several expiry dates, each of which is only valid for a certain period. For instance, the expiration date of index futures is typically the third Friday of each month. The contract would be resolved and can no longer be exchanged.

To start your journey in trading and understanding CFDs or Futures, contact us and speak with one of our representatives immediately.

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